Trust accounting: Identify problem areas now to save trouble later

Wisconsin Supreme Court Rule (SCR) 20:1.15 is a hefty one involving trust accounting. As State Bar of Wisconsin Ethics Counsel Tim Pierce might say, it's a rule that is "fraught with ethical pitfalls." In this article, Mary Hoeft Smith of the Office of Lawyer Regulation explains some of the major pitfalls that can ensnare Wisconsin lawyers.

Nov. 2, 2011 – Managing a trust account involves more than holding on to other people’s money, and the mechanics of properly doing so are not always obvious, according to Mary Hoeft Smith, Program Administrator for the Office of Lawyer Regulation’s (OLR) Trust Account Program.

Smith, who provides education on trust account management, investigates overdrafts, and audits lawyer trust accounts for the OLR, says it’s often the things that lawyers don’t know that can lead to violations of SCR20:1.15.

“For example, a lawyer may be unaware that certain types of transactions are prohibited in connection with a trust account,” Smith said. “Internet transactions, while commonly used in business and personal banking, are prohibited in a trust account because they don’t produce a paper trail documenting the purpose of the transaction and the client matter involved.”

The program gives recently licensed, as well as seasoned lawyers, an overview of common trust accounting infractions that arise. In many cases, Smith says, lawyers make mistakes because they misunderstand the requirements of SCR 20:1.15, or they simply don’t recognize the warning signs of potentially serious problems.

Trust accounting rules

Top-10 tribulations of trust accounting

Believing the myth of non-refundable fees

Overdrawing your trust account because a deposit wasn’t available

Not knowing where to deposit flat fees, or any other fees for that matter

Losing your trust account records in a fire, or a computer crash or other disaster

Finding overlooked deposits in your desk drawer, or learning that trust account checks you paid out in the late 1990s were never cashed

Telling your client that you can’t give him the settlement money he agreed to pay his doctor

Accidentally paying a personal bill from the trust account

Post-dating a check to your client and expecting your bank not to cash it

Discovering that you now owe taxes on trust monies embezzled by your assistant

Finding unidentifiable funds in your trust account when you retire

Most lawyers don’t get trust account training in law school. And even experienced lawyers can forget what is required under the trust account rules without a refresher course.

Under SCR 20:1.15, a lawyer must hold the property of clients and third parties in a trust account separate from the lawyer’s own property. Funds belonging to the lawyer may not be deposited or retained in a trust account, except as necessary to pay bank service charges.

In addition, a lawyer can’t withdraw advanced fees until earned, unless the lawyer complies with the numerous requirements of an alternative to holding advanced fees in trust that are identified in SCR 20:1.15(b)(4m). Furthermore, funds advanced for payment of costs must be held in trust until the costs are incurred. Even the method of withdrawing fees from a trust account is governed by SCR 20:1.15.

“In the fast-paced business of practicing law, a lawyer may mistakenly believe that transferring money electronically or telephonically from a trust account to a business account to pay legal fees is the best way to go,” Smith said. “Unfortunately, while such transfers save time, they provide no way for the lawyer to identify whose money is being transferred and why.”

Consequently, a lawyer still needs to utilize checks to disburse fees, and must identify the client matter and purpose of the payment on the memo line of the check.

Smith says that the most common mistakes in trust account record keeping include failing to properly document deposits and withdrawals and failing to keep a running balance in the register and ledgers. SCR20:1.15(f) identifies specific record-keeping requirements for all trust accounts, including draft and non-draft accounts.

Smith also reminds lawyers that computerized trust account records must be backed up by an appropriate storage device and that, in addition to the electronic back-up, IOLTA records must be printed every 30 days. Failure to perform the required back-ups not only violates SCR 20:1.15(f)(4), it makes reconstruction of the records after a computer crash or natural disaster all the more difficult and time-consuming.

Pursuant to SCR 20:1.15(h), OLR is routinely notified of overdrafts on lawyer trust and fiduciary accounts by the financial institution at which such accounts are located. A fairly common cause of trust account overdrafts is an inadvertent failure to make a deposit prior to disbursing funds, Smith said. She points out that when money is disbursed to a client before an actual deposit is made, the lawyer is improperly using another client’s money to cover that disbursement.

“The best way to avoid this is to review the bank’s receipt for each deposit before cutting a check,” she said. “In addition, be certain that the funds you’re disbursing are ‘available’ under your bank’s fund availability policies."

While some firms hire a bookkeeper or have a bookkeeping department that handles the day to day management of the firm’s accounts, Smith noted that hiring a bookkeeper or accountant is not a complete solution to trust account management because the lawyer remains responsible for managing the account and overseeing the records.

“It’s ultimately the lawyer who will be held responsible, both ethically and financially, if there are problems associated with a trust account,” said Smith. “During the investigation of a trust account overdraft, a lawyer will be asked to explain the cause of the overdraft and produce various records. The lawyer may also be asked what was done to oversee any recordkeeping performed by an assistant.”

Other tribulations of trust accounting

Smith says the upcoming webinar will highlight pitfalls and common problems that lawyers should be aware of in managing a trust account. The webinar may also lead a lawyer to conclude that he or she needs additional training, such as OLR’s semi-annual Trust Account Management Seminar.